Thursday, December 23, 2010

The Story of Income and Outlays

Let me walk through the below chart, which I think tells a very broad story of where we were, what happened during the crisis, and how we are back to our old path with regards to consumption, which makes up ~65-70% of the U.S. economy.

First, the details.

The chart below shows the year over change in items that make up personal income (compensation, transfer payments from the gov't, etc...) and items of expenditure we use that income for (consumption, taxes, etc...). A year over year increase in an income item is a positive, while a year over year increase in an expenditure item is a negative. Combined, we get an increase or decrease in savings (a negative savings amount does not mean savings is negative, just that the level of savings has decreased).



A 1000 foot explanation of what I see...

We spent too much relative to our incomes (due to the belief at the time that we could always tap into the "wealth" of our housing stock). This is seen in the chart through 2007 when savings growth turned negative (savings in absolute terms turned negative in this period as well).

The recession started when a slowing economy turned the pace of growth in compensation and receipt on assets to fall. This combined with an uptick in savings, meant consumption slowed and slowing growth (not a downturn in growth) is all it takes for a levered financial system to be strained.

The government attempted to help the shortfall in aggregate demand through a large spike in transfer payments (the $600 tax check in 2008 + unemployment benefits), but individuals chose to save a large portion of this increase, dampening the impact.

In late 2008, individuals dramatically decreased the pace of consumption to rebuild balance sheets and from all the uncertainty in the system. This caused the issues in the system to become magnified.

By mid to late 2009, due in part to transfer payments and reduced taxes (which caused disposable income to spike), and a bottoming in the financial markets, confidence began to slowly come back to individuals. By early 2010, we have once again been on our old spending path through the reduction of the increase in savings (which has topped out at ~5 to 6%, well below a lot of forecasts for savings rates to spike).

What happens now? While the bush tax cuts mean that taxes won't be a drag for at least another few years, transfer payments can no longer be relied on to increase disposable income. What we need now is the job market to bounce back and compensation to allow for spending.

Spending based on compensation? Go figure...

Source: BEA